Question

When exchange rates are fixed, a temporary expansion in the money supply will:

A increase output

B leave output unchanged

C lower output

D increase the exchange rate

Explain your answer.

Answer 1

When exchange rates are fixed, a temporary expansion in the money supply will leave output unchanged.

Ans - B) leave output unchanged.

Explanation:
When the money supply increases this cause the interest rate to fall which causes the demand for the currency to reduce so this thing start putting pressure on the currency to depreciate. But as exchange rates are fixed so the central bank intervenes and buys the dollars in exchange for foreign currency.This leads to the decrease in the money supply.
Thus, the money supply, and interest rate reach their previous levels and the output remains unchanged.